Science & innovation investment framework, A view from the City

Transcription

1 UBS Investment Research Science & innovation investment framework, A view from the City European Equity Strategy Andrew Barker ANALYST CERTIFICATION AND REQUIRED DISCLOSURES AT END OF NOTE July 2004

2 Question 1 Is the UK stock market an asset or a liability? The share of business R&D accounted for by small and medium sized firms. is high in the UK compared to other major OECD economies Analysis by the OECD suggests that R&D intensity is correlated with the size distribution of distribution of R&D performing firms. This suggests that the UK s lower R&D intensity is, at least in part, due to lower levels of R&D amongst larger UK firms Science & innovation investment framework, p. 60 Capital markets may also provide insufficient opportunities for companies to shift risk, owing to the asymmetric information between investor and company, and the difficulty of securing finance on intangible knowledge assets. Science & innovation investment framework, p. 63 1

3 The UK equity market pre-eminent in Europe The market capitalisation of Europe: UK accounts for 1.7tr out of total 4.8tr 40% 35% 30% 25% 20% 15% 10% 5% 0% 35% 14% 10% 10% 7% 6% 5% 4% 2% 1% 1% 1% 1% 1% 1% 0% 2 UK France Germany Switzerland Netherlands Italy Spain Sweden Finland Belgium / Lux Denmark Ireland Norway Greece Portugal Austria

4 The innovation balance sheet: UK non-financials ASSETS FINANCING tangible fixed assets, net working capital debt investments market value of intangibles 100% market value of equity R&D A&P / brand people growth 62% 3

5 The innovation balance sheet: Honeywell (US) net cash tangible fixed assets, net working capital ASSETS FINANCING investments market value of intangibles 100% market value of equity R&D A&P / brand people 51% growth 4

6 The innovation balance sheet: Smiths Group (UK) tangible fixed assets, net working capital investments ASSETS FINANCING debt market value of intangibles 82% 100% market value of equity R&D A&P / brand people growth 5

7 The value of innovation: UK vs France vs Germany % of market capitalisation accounted for by intangible assets 70% 60% 50% 40% 62% 56% 30% 20% 19% 10% 0% UK France Germany (based on non-financial companies in Eurotop 300 index, and UBS 2004 forecasts) 6

8 The time value of innovation: Smiths Group % of today s market value accounted for by cash flows from different future periods 40% 35% 30% 25% 20% 15% 10% 5% 0% 37% 27% 20% 16% 1st 3 yrs yrs 4-10 yrs terminal value (based on UBS 2004 forecasts; standard dividend discount model) 7

9 Nokia: a salutory case In the last 5 trading days, Nokia has lost 16% of its market value, or E8.6bn /7/04: We increase our R&D estimates by 22% in 3Q04, 13% in 2004 and 10% in R&D spending is tracking higher than expected, due to the desire to fund new programmes to support longer-term product development UBS research note 8

10 Companies are now unusually conservative Cash surplus (deficit), European large-capitalisation companies E 2004E 9

11 Conservatism is being rewarded 2004 PE multiple of Portugal Telecom, announcement of share buy-back buyback programme is announced Jul-03 Aug-03 Sep-03 Oct-03 Nov-03 Dec-03 Jan-04 Feb-04 Mar-04 Apr-04 10

12 Question 2 Is there any evidence in the long-term that investors gain from supporting companies in their R&D efforts? 11

13 Does science and innovation pay? (investors view - 1) Methodology creating an R&D portfolio We ranked all stocks in the US Russell 2000 (index of top 2000 quoted US companies) by their ratio of R&D to total assets, every month for the past 25 years: 600,000 data points We selected the top and bottom quintiles on this measure every month, and constructed a portfolio to go long of the top basket, and short of the bottom one We measured the cumulative returns to this portfolio strategy over time In other words, we have tried to isolate the total returns to an investor in the US stocks that (in each month) are spending the most on R&D. It does not represent the performance of the individual stocks from end to end: the position of the stocks in the rankings may change over time. 12

14 Does science and innovation pay? (investors view - 2) How the R&D portfolio would have performed over the last 25 years, US Russell 1000 (larger companies) Jan-79 Jan-81 Jan-83 Jan-85 Jan-87 Jan-89 Jan-91 Jan-93 Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 13

15 Does science and innovation pay? (investors view - 3)..substituting capital spending for R+D Jan-79 Jan-81 Jan-83 Jan-85 Jan-87 Jan-89 Jan-91 Jan-93 Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 R1000 R2000 R1000G R1000V

16 Does science and innovation pay? (investors view - 4) Investors prefer large company R+D over small company R+D Jan-79 Jan-81 Jan-83 Jan-85 Jan-87 Jan-89 Jan-91 Jan-93 Jan-95 Jan-97 Jan-99 Jan-01 Jan-03 R1000 R2000

17 Does science and innovation pay? (investors view - 5) Results by sector are very different the R&D-sensitive ones Jan-79 Jan-80 Jan-81 Jan-82 Jan-83 Jan-84 Jan-85 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Information Tech Materials Industrials Health Care

18 Does science and innovation pay? (investors view - 6) Results by sector are very different the less R&D-sensitive ones Jan-79 Jan-80 Jan-81 Jan-82 Jan-83 Jan-84 Jan-85 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Consumer Staples Energy Consumer Discre

19 Question 3 Is the UK financial services industry an asset or a liability? The City of London is one of the most competitive financial services clusters in the world. The UK ranks 1 in the Global Competitiveness Report on the sophistication of its financial markets. Its equity markets in particular are rated highly UK Competitiveness: moving to the next stage, (Porter and Ketels) p

20 The UK finance industry pre-eminent in Europe European equity markets location of intellectual capital 100% 80% 60% 40% 20% 0% -20% UK France Germany Switzerland Italy local london export (according to UBS equity analyst location) 19

21 UK finance industry major development spenders UBS Investment Bank global headcount by category 32% 5,438 48% 8,269 20% 3,455 client facing IT development operations 20

22 The UK finance industry shading out the rest? The relative significance of stock market careers: US = UK US Japan Switzerland Germany Italy France (according to UBS equity analyst location, market share) 21

23 One investment analyst / engineer s career path Graduated from University of York in 1986, with BSc, electronic engineering Joined Plessey Electronics, in Electromagnetics Consulting Group, specialising in advanced electronic designs of military equipment I decided to leave Plessey after my first annual review, when I was told that I could not achieve the next grade because the minimum age requirement was 24 Became investment analyst following electronics and industrials companies Was voted in top 3 aerospace / defence analysts in the world, 2000 and 2001, and best analyst in Europe Now UBS Managing Director and head of Telecom research team 22

24 Conclusions Question 1: The UK has a noticeably larger and more liquid stock market than those of its competitors. This market takes a long-term view, and already values science and innovation highly. It should be in a position to facilitate, rather than hinder, UK business R&D. At the moment though, market conditions around the world are hostile towards any kind of long term investment. Question 2: in the long run, the US experience suggests that equity investors should profit from a policy of favouring firms with high R&D, although this is most true for larger companies, and for certain sectors. Question 3: The UK wholesale financial services industry is highly productive, and exports successfully. It is itself, though, a major pull on the UK s scientific / innovative talent pool: is there any way of redressing the careers imbalance? 23

25 Analyst Certification Each research analyst primarily responsible for the content of this research report, in whole or in part, certifies that with respect to each security or issuer that the analyst covered in this report: (1) all the views expressed accurately reflect his or her personal views about those securities or issuers; and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by that research analyst in the research report. Global ratings: Definitions and allocations UBS rating Definition UBS rating Definition Rating category 1 Coverage 2 IB services 3 Buy 1 Neutral 1 Reduce 1 Excess return potential > 15%, smaller range around price target Buy 2 Excess return potential between -15% and 15%, smaller range around price target Neutral 2 Excess return potential < -15%, smaller range around price target Reduce 2 Excess return: Target price / current price gross dividend yield - 12-month interest rate. The 12- month interest rate used is that of the company's country of incorporation, in the same currency as the predicted return. US Closed-End Fund ratings and definitions are: Buy: Higher stability of principal and higher stability of dividends; Neutral: Potential loss of principal, stability of dividend; Reduce: High potential for loss of principal and dividend risk. UK and European Investment Fund ratings and definitions are: Buy: Positive on factors such as structure, management, performance record, discount; Neutral: Neutral on factors such as structure, management, performance record, discount; Reduce: Negative on factors such as structure, management, performance record, discount. 1: UBS Buy 1/Buy 2 = Buy; UBS Neutral 1/Neutral 2 = Hold/Neutral; UBS Reduce 1/Reduce 2 = Sell. 2: Percentage of companies under coverage globally within this rating category. 3: Percentage of companies within this rating category for which investment banking (IB) services were provided within the past 12 months. Source: UBS; as of 31 March Excess return potential > 15%, larger range around price target Excess return potential between -15% and 15%, larger range around price target Excess return potential < -15%, larger range around price target Buy 47% 35% Hold/Neutral 47% 32% Sell 6% 26% This report was produced by: UBS Limited Head office: UBS Limited, 1 Finsbury Avenue, London, EC2M 2PP, UK Phone: This report has been prepared by UBS AG or an affiliate thereof ("UBS"). In certain countries UBS AG is referred to as UBS SA. This report is for distribution only under such circumstances as may be permitted by applicable law. It has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. It is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. 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